USD/BRL analysis and the Brazilian real carry trade opportunity

The Brazilian real weakened slightly against the US dollar after last week’s Federal Reserve and Copom interest rate decisions. The USD/BRL exchange rate rose to a high of 5.7285 on Monday, its highest point since March 17. It remains about 10% below the highest point in December last year when the Brazilian real crashed. 

Fed and Brazil central bank decisions

The USD/BRL exchange rate has been in focus in the past few months as it became a key carry trade player. A carry trade is a situation where investors borrow a low-interest-rate earning currency and invest in a high-interest rate one. 

US and Brazilian interest rates have moved in the opposite direction in the past few months. In the US, the Federal Reserve has lowered rates from 5.50% in 2024 to the current 4.50%. The Brazilian central bank has been on a hiking cycle in the past few months.

The Fed has hinted that it will continue lowering interest rates. In its meeting last week, the Fed left interest rates unchanged as the dot plot pointed to two more cuts later this year. Some analysts predict more than two cuts if Trump’s tariffs derail the economy. Therefore, there is a likelihood that rates will end the year around 3.5%.

The Brazilian Central Bank, on the other hand, has been on a hiking cycle as it battles the steady inflation. Recent data showed that the headline Consumer Price Index (CPI) rose to 5.06% in February from 4.56% a month earlier. It has jumped from last year’s low of 3%. This inflation has grown partly because of the substantial government spending.

The bank hiked rates by 1% last week, the third consecutive time. It brought the benchmark interest rates to 14.25%, the highest point since 2016. However, officials hinted that the pace of hikes will be lower in the next meetings. Analysts see the bank hiking by 0.50% for the final period in May.

Carry trade opportunity

The divergent path of the Federal Reserve and the Brazilian Central Bank has created a carry trade opportunity. 

In this, investors are borrowing the US dollar and paying, in theory, 4.50%, and then investing in Brazilian government bonds. Data shows that the Brazilian ten-year government bonds are yielding about 15%, while the five-year are yielding 14.50%. These yields are much higher than those in the US.

A carry trade often works well, especially when the other currency is stable. In the Brazilian case, the real has jumped by almost 10% from its highest level in December last year, making the carry trade highly profitable.

The USD/BRL pair has also dropped because of the potential trade war between the US and China. Its implication is that Brazil will benefit from more agricultural exports to China now that the government has imposed tariffs on US crops. The challenge, however, is that Brazil is still facing a drought that may affect its output.

USD/BRL technical analysis

USDBRL chart by TradingView

The daily chart shows that the USD to BRL exchange rate peaked at 6.3130 on December 9 last year to the current 5.7285. It has moved below the key support at 5.8620, the highest swing on August 5 last year. 

The USD/BRL pair has formed a death cross pattern as the 50-day and 200-day Weighted Moving Averages (WMA) flipped each other. Therefore, the pair will likely continue falling as demand for the Brazilian real continue rising. Such a drop would see drop to the next key support at 5.50, down by 4% from the current level.

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